Employ Your Children, and Save Big

Published on Monday, December 23, 2019

For some parents, the thought of bringing their child to work with them every day may sound less than appealing, but for owners of LLC’s and partnerships, the tax law offers some enticing provisions which makes the prospect of hiring your children a potentially powerful savings tool.

Save on Payroll Tax

The IRS has stated that payments for the services of a child under age 18 who works for his or her parent in a trade or business are not subject to employee or employer Social Security and Medicare taxes if the trade or business is a sole proprietorship or a partnership in which each partner is a parent of the child. This means that if you own a sole proprietorship, or you and your spouse are the ONLY partners in a partnership, you NEVER have to pay Social Security or Medicare taxes for any of your children (under the age of 18) you employ, regardless of how much they make! Furthermore, the IRS states that payments for the services of a child under age 21 who works for his or her parent in a trade or business are not subject to Federal Unemployment Tax Act (FUTA) tax either.

Save on Federal Income Tax

Despite never having to pay any payroll tax, the payment for the services of a child are subject to income tax withholding, regardless of age. That being said, the Tax Cuts and Jobs Act (TCJA) have sweetened that deal by increasing the standard deduction from $6,350 prior to the TCJA, to $12,400 in 2020. So, a parent could potentially hire their child and pay them up to $12,400 before either the child, or the parent pay a dime in federal tax for their labor. And, of course, the wage that child is paid is also fully deductible on the tax return of the business.

Fund a Roth IRA

As many parents quickly realize when trying to get a head start on saving for their children’s retirement, you must have earned income in order to contribute to a Roth IRA. While employing your children, on top of the tax savings, their income they receive from the family business is completely eligible to be contributed to a Roth IRA, with contribution limits of up to $6,000 in 2020.

Limitations

Please note that this does not include S-Corporations. Your children would be subject to the same taxation as any other employee would regardless of their age or relation to you. Also, parents need to be aware that their child would have to be paid a fair wage for their labor, and must actually perform the work they claim they are being compensated for. So, unfortunately, you may be hard pressed to find suitable work for your newborn!

If you have any questions please give us a call, or come and visit us at our new location!

Aaron Lavarias, CPA, Tax Manager